For a very long time, the price of gold did nothing but go up. After all, gold is considered by many to be the ultimate safe-haven asset in times of economic uncertainty.

However recent history suggests gold may be losing its shine. From a record high of US$1921 an ounce in early September 2011, the price of gold has slid around 20% to be currently trading just above US$1550.

What has driven this decline and is there further weakness in store for gold? In today's editorial we will attempt to answer these questions.

Recent history

As we can see from the chart below, there was an almost uninterrupted run-up in gold prices for much of the 2000s. The price of gold has surged over 400% in the past 11 years!

What drove this run-up? A few factors.

The tech wreck of the early 2000s sparked a mini-collapse in equity markets and dented investor confidence in some of the riskier asset classes.

In response, the US Federal Reserve (Fed), under the chairmanship of Alan Greenspan, embarked on a plan to keep interest rates as low as possible for as long as possible.

While this was followed by an equity market boom, investors became increasingly concerned about the potential for easy money conditions to result in higher inflation in the US (which eventually occurred).

Low interest rates and a widening US current deficit led to a structural decline in the US dollar, so more and more investors went looking for the next safest alternative asset - gold.

The panic induced by the GFC briefly lured investors back to the US dollar, but aggressive monetary easing policies by the Ben Bernanke-led Fed led to another major run-up in gold prices (again due to inflationary fears).

What has changed?

The chart shows gold topping out above US$1900 and since September 2011, it hasn't really threatened to create a new high.

So what has changed? Although the US dollar is still weak compared to a number of other currencies, on a trade-weighted basis, it has rebounded noticeably over the past two years (shown below).

The hyperinflation many feared would result from the monetary easing measures implemented by the world's central banks never occurred. Gold's inflation 'premium' therefore is being slowly eroded.

As these inflationary fears subside the prospect of a collapse in the US dollar diminishes, which in turn is providing renewed support for the greenback at the expense of gold.

ETFs and the immediate outlook for gold

In a sign of just how serious the recent collapse in gold prices is, bullion holdings at exchange traded funds (ETFs) have fallen significantly in 2013, as we can see below:

The drop in ETF holdings highlights the extent to which investment demand is weakening.

The rationale for holding significant amounts of bullion is losing its validity; fears of quantitative easing-induced hyperinflation are abating and other asset classes like equities are offering relatively stronger returns.

The actions of ETFs carry particular significance because they are key players in the gold market. EFTs are dumping supply into the market at a time of weak demand, something that may continue weighing on the price of gold for a while yet.

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